Congress vs. Bernanke on Borrower Protection

A good old-fashioned showdown is set for this week between the Congress and the Fed. Congressmen are hoppin’ mad at the Fed’s failure not only to act to stem overheated and sometimes predatory subprime lending, but also its patent lack of enthusiasm in doing anything to keep this and other predatory practices from recurring. And they have some justification for their annoyance. While admittedly the Fed regulates only a portion of the institutions that were involved in subprime lending, it failed to use the tools it had available, most notably the Home Ownership and Equity Protection Act (by contrast, the Office of the Comptroller of the Currency, made use of HOEPA and had relatively few abuses among the banks it supervises).

There is a reason the Fed has been so tone deaf on this issue. It does not see borrower protection as part of its job (it isn’t part of the original Fed charter) and the little we’ve seen directly also suggests the Fed is a staunch believer in free market ideology (remember, Greenspan was an acolyte of Ayn Rand and Bernanke hasn’t had the time to put his own stamp on the institution).

Congress is threatening aggressive moves, namely, moving some of its regulatory authority to other agencies, if the Fed doesn’t fall into line. This should be a very interesting set of meetings.

From the Wall Street Journal:

The Federal Reserve, under fire on Capitol Hill for not protecting consumers more aggressively from dubious banking practices, will likely become more assertive toward the lending and marketing practices of the nation’s more than 35,000 banks, credit unions, finance companies and mortgage brokers.

In the wake of a meltdown in the market for subprime mortgages and increasing congressional scrutiny of practices in the credit-card industry, Democratic leaders have blasted the Fed’s regulatory performance.

The form that any changes in the Fed’s regulatory approach might take isn’t clear, but they could affect anything from credit-card payments to mortgage penalties.

The central bank has broad authority to prohibit banking practices it deems unfair and deceptive, an important role that receives far less attention than the setting of monetary policy.

This year’s political assault on the Fed’s consumer-protection record may reach a crescendo this week, with Fed Chairman Ben Bernanke set to face lawmakers during two days of congressional testimony starting tomorrow. Mr. Bernanke, entering his second year at the Fed’s helm, is still trying to cement his stature with lawmakers the way he did quickly with Wall Street.

“They had a job to do, and they didn’t do it,” said Senate Banking Committee Chairman Christopher Dodd, (D., Conn.), of the Fed’s performance. “A lot of people are hurt, and I’m angry about it,” added Mr. Dodd, who is seeking the Democratic presidential nomination.

The pressure on the Fed represents one of the most significant challenges to its authority in decades. House Financial Services Committee Chairman Barney Frank (D., Mass.) has threatened to give some of the Fed’s jurisdiction to other regulators if the central bank doesn’t begin making changes by the fall. Moreover, three nominees to the Fed’s seven-member board are awaiting confirmation by Mr. Dodd’s Senate committee.

“There is a deep level of anxiety and frustration in every [congressional] office, everyplace we go on this issue,” Alfred A. DelliBovi, president of the Federal Home Loan Bank of New York, told Fed governor Randall Kroszner during a recent meeting. “It seems to me that either the Fed is going to have to act on this or [its powers] will be moved somewhere else.”

It remains unclear whether the Fed’s regulatory woes will hurt Mr. Bernanke’s monetary-policy goals. But Mr. Frank dismissed the idea. “Are we resisting Bernanke’s monetary policy because of this? That’s ludicrous.”

Under former Chairman Alan Greenspan, who stepped down last year, the Fed successfully accumulated broader regulatory jurisdiction over banking and consumer protection, in part because of its reputation for independence.

The central bank now is the only government body that can write rules banning any practice it deems unfair and deceptive at the nation’s more than 7,000 banks. It is also the only agency that can prohibit any mortgage practice across the entire lending industry.

Instead of aggressively using these tools, the Fed has tried to take a market-based approach: encouraging fair disclosures and trying to root out bad actors quietly, rather than wielding a heavy hand that might deter innovation. This has allowed the financial-services industry to develop novel and flexible types of credit, such as interest-only mortgages. But critics allege that this approach has also allowed questionable practices to entrench themselves with little scrutiny.

Three of the five current Fed governors — Mr. Bernanke, Kevin Warsh, and Mr. Kroszner — have been economic-policy advisors to the White House, which has a similar market-based philosophy with regard to financial-services regulation.

Other federal agencies have moved faster to head off congressional criticism. Comptroller of the Currency John Dugan started a Web site last week to help consumers resolve issues with their banks. Federal Deposit Insurance Corp. Chairman Sheila Bair has pressed banks to move borrowers with expensive adjustable-rate mortgages into more affordable fixed-rate products. And the Office of Thrift Supervision has begun working on its own proposal to ban unfair and deceptive practices at more than 800 federally insured thrifts.

Faced with the possibility that some of its power might be scaled back, the Fed is changing its rhetoric.

In May, Mr. Bernanke said the central bank had the authority to prohibit certain mortgage practices. Mr. Dodd objected, saying the Fed was playing down its role. A month later, Mr. Bernanke shifted, saying the central bank “has the responsibility to prohibit mortgage lending practices that it finds to be unfair and deceptive.”

The Fed held a daylong public hearing last month to discuss different ways it could use its authority, and senior officials have begun speaking much more bluntly about the types of actions it could eventually take.

“We have not taken anything off the table,” said Sandra F. Braunstein, director of the Fed’s division of consumer and community affairs. “We are willing to use any of the tools available to us, that includes rule writing or banning practices or anything else we feel is necessary.”

As criticism of the Fed intensified last month, Mr. Bernanke held a closed-door meeting with roughly 40 members from the Association of Community Organizations for Reform Now, a consumer group that has asked for a moratorium on all foreclosures stemming from problems in the subprime mortgage market.

It is unclear what types of practices the Fed might try to abolish, but that hasn’t stopped consumer groups and Democrats from making suggestions. One of the most frequently criticized is a credit-card practice known as double-cycle billing, which allows companies to charge customers interest on almost all their credit-card balance even if the borrower pays off almost all of it by the due date. Another: Prepayment penalties on mortgages, particularly those that penalize a borrower for trying to pay off an adjustable-rate mortgage before it resets into a much higher monthly payment.

Last month, the Fed and other regulators warned banks away from such mortgage penalties, but it didn’t use its rule-writing authority to ban the practice across the industry.

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  1. Anonymous

    You Say:
    “The central bank now is the only government body that can write rules banning any practice it deems unfair and deceptive at the nation’s more than 7,000 banks.”

    As far as I know, “The Fed” is NOT A Government Body. It is owned by a portion of the 7000 banking interests, You appearantly expect it to regulate?

  2. Yves Smith

    First, the sentence you find objectionable came from the Wall Street Journal. Second, the Fed does have regulatory powers. I quote The New Palgrave Dictionary of Money & Finance, from an article signed by Richard Sylla, Henry Kaufman Professor of The History of Financial Institutions and Markets and Professor of Economics at the Stern School, NYU’s business school:

    “The Federal Reserve System, or “Fed” in common parlance, is the central bank of the USA. It was founded explicitly as a central bank in 1913. In this respect the Fed differed from the central banks of the leading European banks of the last century. Those central banks evolved gradually over decades into bankers’ bank, holders of their nation’s ultimate monetary and banking reserves, lenders of the last resort, sole issuers of banknote currency, and supervisors and regulators of ordinary commercial banks….From its inception, the Fed took on all these responsibilities save one. It never carried on ordinary commercial banking business…..

    “The original Federal Reserve Board was made up of five members appointed to staggered ten-year terms by the US president and two ex officio members, the Secretary of the Treasury and the Comptroller of the Currency. Thus the Board, unlike the Reserve Banks, was a governmental organization. Its purpose was to oversee and supervise the operations of the Reserve Banks, to coordinate their activities, to handle the System’s relations with the Federal government, and in general to bring about a uniform banking and monetary policy in the US….

    “Banking supervision, or monitoring, involves continuous oversight of individual banks to assure that they are operated in a safe, sound, and prudent manner consistent with banking laws and regulations.”

    The article also describes how the composition of the Board was changed during the Great Depression to give it greater independence from the Treasury and the terms of Board members were lengthened to impede the ability of any one US president to stack the Board. Its regulatory powers were also strengthened then, as was its authority over the Reserve Banks.

  3. Anonymous

    The sentence is not objectionable except that it perpetuates the erroneous concept that the fed is a GOVERNMENT watchdog rather than a private franchise owned by the banking industry! It’s a watchdog for the banking industry and is maybe not so concerned about consumers.

    I do not possess the credentials of the authors you cite in your comment, or, even your own sterling credentials in capital markets. I am a lowly bond investor who could have predicted the outcome of deregulated banking especially with respect to the mortgage market “easy money potboil” conduced by the PRIVATE “Federal Reserve”. From my perspective the Quants got caught up in their own underwear while feasting on the lower classes dream of home ownership. It’s is not that deep.

    It is an engineered boom and bust cycle fueled by “funny money” which was created by the banking industry. Until the pros admit to themselves that a financial structure built on “wild west” mentality of unregulated gluttons is incompatible with the concept of “consumer protection” nothing is surprising.

    What? You want me to think this is some unforeseen aberration?

    Love your site.


    PS I am always reassured by an independent board just like Enron had.

  4. Yves Smith

    As we’ve said before, the Fed hasn’t seen itself in the consumer protection business (and we are most assuredly in favor of certain types of borrower protection). In part, that’s due to its charter. The Fed’s job has been to assure the safety and stability of the banking system and the soundness of the currency. Nada about consumers in its charter (in fact, they were called “customers” back then).

    But in the old days, banks were more at risk from their customers than vice versa. which we discussed at considerable length here: So it wasn’t crazy historically not to have much in the way of borrower protection beyond, say, usury ceilings (which BTW have been effectively gutted by a Supreme Court decision plus competition between states for banking jobs; see No one would have foreseen that debt would be marketed as aggressively as breakfast cereal.

    Now having said that, regulators are often creative and seek to adapt their mandates to changing times. The Fed most certainly hasn’t done that here.

    As to your other point, the Fed being complicit in our bubble economy, I agree, but I don’t see that as inherent to the Fed’s operation. In fact, bubbles like this end in either deflationary collapses or pronounced inflation (which way it goes depends on the actions taken by the key actors in the late chapters). Either outcome is very bad for banks and hence to be avoided. And Fed chairmen before Greenspan understood that and acted accordingly. Former Federal Reserve chairman William McChesney Martin defined the job of the Fed as taking away the punchbowl just when the party started getting good. Paul Volcker presided over a very difficult but necessary clampdown on money supply that precipitated a nasty recession but succeeded in wringing corrosive inflation out of the system. The pandering to free markets and indifference to speculation is a Greenspan phenomenon. I am waiting for the downgrading of his reputation to begin.

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